The car finance industry has grown rapidly since 2015. Mark Carney, Governor of the Bank of England has said that lenders are forgetting the lessons of the past as finance companies rush to lend to drivers with bad credit ratings or low wages. Many of these deals do not have up front deposits and are done on personal contract purchase or PCP plans.
These work by Paying a monthly fee during a contract period of normally 2 or 3 years with an option to purchase the vehicle at the end of the contract period or handing it back and taking a new vehicle on a similar contract.
It is now ten years since the global financial crisis which saw a meltdown in subprime mortgages, bringing financial institutions to their knees, now it’s not about mortgages but car finance.
Whilst the recovery of the UK economy has been based on low interest rates, making borrowing cheap, the very fact that it is cheaper to borrow has seen consumer credit spiralling out of control. The real beneficiary here is car finance, which has outstripped credit card and personal loans.
The financial Conduct Authority (FCA), the city and financial regulator, is looking into the car finance sector. The FCA is worried about how debt is rising and its implications for the economy after concerns about the size of debt and worries over irresponsible lending, conflicts of interest and lack of transparency. It is looking at the way in which these financial products are sold.
Two thirds of new car buyers now rent their vehicles through PCP plans. This has been accumulating over the last 10 years and some have asked why it is only now that the FCA have begun to look into it.
Reports recently, suggest that many people who may be at risk of making the payments to such a plan, unemployed graduates and those with low incomes for instance, are being accommodated with no deposit plans, even though their ability to make the repayments is in question. It is not the customers, however, who are at risk here, as those who fail to make payments will simply have the vehicle repossessed. The concern, according to some financial and economic analysts is that an increase in interest rates or unemployment could result in borrowers, nationwide, defaulting on their loans which may prompt another financial crash. At the same time, banks are failing to set aside a decent capital buffer.
Some believe this could lead to a dangerous situation.
Car finance is largely funded by the manufacturers funding houses, so it would not just be banks who suffer. The manufacturers could be exposed to losses if car sales start to decline and vehicles are repossessed. The decline in value of the returned stock and economic downturn could have a serious effect on the industry.
Figures suggest that the subprime lending makes up only 3% of the market but concerns are growing that the figures could be worse than previously thought. Credit has surged in recent years due to relaxation in the standards of underwriting and low interest rates. Last year in the UK, people borrowed £31.6bn to spend on their cars. If the lenders are hit with big losses, the knock-on effect in the industry could be severe.